Saturday, January 26, 2008

Questions on Economics You've Always Wanted to Ask

If you've never studied Economics, (or maybe you did study Economics, but never understood it) this article hopes to be a brief guide to understanding the basics of what is going on in the economy. It is part of a blog writing project by Daily Blogging Tips. Some of the material may be familiar to regular readers, but these are some of the most common questions asked about the economy at the moment. Hopefully, they will answer some common questions on Economics.

What is a Recession and is America in a recession?

A recession is a period of negative economic growth, it means output and average incomes will fall. A recession will lead to higher unemployment and a decline in living standards. The US is not currently in a recession, because the economy is still expanding; however, there are fears it will enter into a recession soon. It is argued falling house prices and other factors, will lead to a decline in consumer spending and this could lead to a fall in output.

How Much Debt does the Government have and why do they borrow so much?

The US national debt is about $9,000 bn and growing. This equates to 65% of National GDP. The US government owe more money than the combined size of several medium sized economy. This debt is also likely to get bigger if the US goes into a recession.
  • The main reason governments tend to borrow so much is political factors. A presidential candidate would not become popular by promising to increase taxes and cut spending (what is required to balance the budget). Cutting taxes and increasing spending tend to be more politically popular. However, the drawback is that the government have to pay interest on the debt. In 2007, over $430bn a year was spent on just paying interest payments on the government debt. - Just think what could be done with $430bn a year...
  • The funny thing is that governments will think nothing of lecturing their citizens about the need to save and avoid irresponsible borrowing.

What is the Sub Prime Crisis?

In the early 00s interest rates in the US were very low (1.5%) and house prices were rising. Many people thought house prices would always rise forever. Therefore, many mortgage companies tried to sell as many mortgages as possible. They used aggressive sales techniques to sell mortgages to people on low incomes, often with bad credit histories (and often immigrants). The mortgage products were attractive for the first year or two, but, then become much more expensive. (but, this often wasn't explained).

A couple of years later interest rates increased and house prices stopped growing. Many people on low incomes could no longer afford their mortgage payments which had suddenly shot up. Therefore, many people with subprime mortgages defaulted (i.e. stopped paying) Therefore, banks who had lent money for mortgages lost it all. Billions of dollars has been lost in mortgage defaults. However, it didn't just effect the mortgage companies, because the mortgage companies were clever (i.e. greedy) they sold their mortgage debts to other banks. This enabled them to lend even more. Therefore, when subprime mortgage companies went bankrupt the whole financial system suffered from the losses.

How does the Sub Prime Crisis effect me?

If you try to borrow now, you will find it difficult and more expensive because banks are being much more cautious. Also the defaults contributed to falls in US house prices and this could lead to a recession.

What is Inflation?

Inflation is a sustained increase in prices. - Inflation means the value of money decreases.
  • A simple example of inflation: The price of bread today is £1.00. 30 years ago, you could get a loaf for 9p.
  • The inflation rate measures the annual % change in prices. In the UK and US, inflation is about 2%. (most prices are rising quite slowly)

Why Do Economists Worry so Much About inflation?

A good question. In a sense it doesn't matter if prices go up, so long as your income goes up as well. However, periods of high inflation can lead to great instability. When inflation gets out of control money loses its value and in extreme cases, people may have to resort to a barter economy. (for example Weimar Germany in 1923 )
In modern economies this is unlikely, but economists worry that inflation is a sign that the economy is growing too fast and is unsustainable. It is argued low inflation enables stronger growth in the long term. For this and other reasons governments like to target low inflation.

If you would like to ask a question on Economics feel free here:

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